Earnings Call Transcript - VRT Q3 2024

Operator, Operator

Good morning. My name is Nadia, and I'll be your conference operator today. At this time, I would like to welcome everyone to Vertiv's Third Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. Please note this call is being recorded. I would now like to turn the program over to your host for today's conference call, Lynne Maxeiner, Vice President of Investor Relations.

Lynne Maxeiner, Vice President of Investor Relations

Great. Thank you, Nadia. Good morning and welcome to Vertiv's third quarter 2024 earnings conference call. Joining me today are Vertiv's Executive Chairman, Dave Cote; Chief Executive Officer, Giordano Albertazzi; and Chief Financial Officer, David Fallon. Today we have a few additional slides to cover in our presentation. We will let the Q&A portion of the call go an additional ten minutes if needed, up until 12:10 p.m. Eastern Time. We would kindly request to please limit yourself to one question, and if you have a follow up question, please rejoin the queue. Before we begin, I would like to point out that during the course of the call, we will make forward-looking statements regarding future events, including the future financial and operating performance of Vertiv. These forward-looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. We refer you to cautionary language included in today's earnings release, and you can learn more about these risks in our annual and quarterly reports and other filings made with the SEC. Any forward-looking statements that we make today are based on assumptions that we believe to be reasonable as of this date. We undertake no obligation to update these statements as a result of new information or future events. During this call, we will also present both GAAP and non-GAAP financial measures. Our GAAP results and GAAP to non-GAAP reconciliations can be found in our earnings press release and in the investor slide deck found on our website at investors.vertiv.com. With that, I'll turn the call over to Executive Chairman, Dave Cote.

Dave Cote, Executive Chairman

Good morning. Q3 was another very strong quarter across the board on every metric: sales, income, cash flow, and orders. Fourth quarter guidance is strong and sales for 2025 look even stronger based on excellent performance. Importantly, there is more positivity ahead as our portfolio expands, new products are introduced, and the Vertiv Operating System, or VOS, becomes a reality. There are two areas I'd like to address specifically where investors seem to oscillate between fear and excitement. The first is AI reality and the second is liquid cooling. We had the agricultural revolution, then the industrial revolution, and now we're only about 40 years into the digital revolution. AI is just the next step in that digital revolution. AI is real, and it has just begun. It has a long way to go. Data centers are fundamental to all that computing. There is no other alternative even on the horizon. Distributed architecture enhances the need for data centers; even quantum computing relies on digital-based data centers. We've enjoyed extremely strong orders in the first half of 2024, and we would agree that continued approximately 60% order increases are unlikely as we tried to say last quarter. By the same token, we are seeing robust backlog building growth supporting orders continuing. Cloud and AI reinforce each other and drive the need for a lot of computing. Additionally, the AI ramp-up in countries outside the U.S. is just beginning. This bodes extremely well for Vertiv as a market leader in data center infrastructure. As the data center infrastructure develops, liquid cooling increasingly comes to the fore, and we continue to rapidly gain share. There are various parts to a liquid cooling system, and like all our products, we've worked to position ourselves in the high IP and know-how areas, specifically, CDUs and total systems. There are several charts in this presentation to simplify understanding of a liquid cooling system, our position, and why we will continue to gain share in this rapidly growing market. Our data center products portfolio is the broadest in the industry. It's also important to note that while rapidly growing, we are not just in liquid cooling. Everything is growing well. We have extensive coverage in thermal systems, power management, IT solutions, modular solutions, and services. AI and data center growth in this digital age benefits everything we do, not just liquid cooling. While it's true there is competition in liquid cooling, that's also true of all our markets. We won't win 100% of all orders, but I believe we will continue to gain share because of our technology base and broad portfolio, global scale, deep industry expertise, global service, and strong customer relationships. These are distinguishing characteristics that others in the market can't match. Vertiv's role is an important one in the industry. We worked very closely on roadmap consistency with key technology providers to be ready for today and to see around the corners to what the industry needs to do next. A great example of this is the joint announcement we did last week with NVIDIA, highlighting the co-development partnership for the AI factories of the present and future. The industry needs to be ready for this new era of compute, and Vertiv is working closely with our customers to ensure that they will be ready for what is coming. While there is intense focus right now on every aspect of AI and the data center market, I would encourage investors who scare themselves about the AI future or Vertiv's role to instead take a longer-term view of the secular growth story in front of us. There is a multi-decade growth trajectory unfolding. Competition is not a new phenomenon, and we expect there to be competitors in the market, as there always have been. Vertiv's advantages, though, are not easily replicated, and we are further expanding them. That is what I saw five years ago as I looked at this unique company: market leadership, global scale, technology differentiation, great end markets, and longstanding customer relationships. The foundational elements for value creation were there, but it needed to be unlocked in a convincing way with strong leadership. I credit Gio and his team for doing the hard work to unlock the full potential of Vertiv. We are still far from our full potential, and that is the most exciting part as I think about what is coming next quarter, next year, and for many years ahead. And it is certainly supported by our orders and operational performance. So with that, I will turn the call over to Gio.

Giordano Albertazzi, CEO

Well, thank you. Thank you, Dave. And we go to Slide 3. This was another strong quarter. Q3 organic sales were up 19%, with double-digit growth in all three regions. Orders grew 37% on a trailing 12-month basis, meeting our expectations, thanks to a 17% year-on-year increase despite tougher comparatives. The demand we see is resilient, and this 37% trailing 12 corroborates the ambition for long-term growth. Adjusted operating profit at $417 million beat guidance. The adjusted operating margin expanded by 310 basis points to 20.1%. This is our first time surpassing the 20% mark, an indication of the potential ahead. Adjusted free cash flow was $336 million in the third quarter, and we have generated $773 million year-to-date. Leverage reduced to 1.4x as of the end of Q3, while we continue to strengthen our balance sheet. We again raised our full year guidance across all financial metrics and expect organic growth of 14%, an adjusted operating profit of $1.485 million, and margins expanding to 19%. We also anticipate adjusted free cash flow of $1 billion, up $125 million from previous guidance. The order trends and our robust backlog indicate that growth in 2025 will accelerate relative to 2024’s 14%. Let’s go to Slide 4. As stated, our trailing 12-month order growth at 37% remains very convincing. Pipelines continue to grow, and we saw a pipeline increase sequentially from Q2 to Q3 across all regions. We are also seeing more convincing signals that AI is indeed accelerating in EMEA. We are not providing a view on Q4 orders; do not read too much into this. Orders are hard to forecast. They can be lumpy, exact timing often outside our control, and it ultimately depends on when the customer is ready to issue a purchase order. With that said, I’d also like to assure you that we feel good, in fact, quite encouraged, that the order trajectory will remain healthy and support the financial ambitions that we are targeting. Our backlog continues to strengthen, reaching $7.4 billion at the end of Q3, and this supports our view that growth will accelerate from 2024 to 2025. Let’s now look at the right side of Slide 4. We have a sharp focus on our capacity to ensure we stay ahead of the demand signals and enable growth. We continue to expand capacity. One example is the recently announced, newly integrated, modular solutions facility in the Americas. This facility has started production and shipments in the third quarter and is helping us meet our customers' needs for rapid data center capacity deployment. Our focus on supply chain is intense. We see the demand trajectory unfolding for years ahead, and we’re making sure our supply chain is resilient in terms of supplier redundancy and geographic diversity. Inflation will continue, and we incorporate that expectation into how we approach our commercial excellence programs. The Vertiv Operating System continues to deliver incremental capacity, productivity gains, and reduced lead times, which are fundamental to our ability to execute at speed and scale. Let’s go to Slide 5 now. We have a few slides in the presentation to fully describe our position in thermal management, specifically liquid cooling for data centers. Let’s start broad. Vertiv has the most complete portfolio of critical, digital infrastructure products, solutions, and services. Sales are well balanced across the five business groups: power management represents 32% of our business; thermal management 30%; IT systems 10%; infrastructure solutions 5%; and services 23%. The impact of AI is favorable to the entire Vertiv portfolio in terms of total volume and total addressable market per megawatt. The total vertical opportunity is much larger than just the opportunity in thermal, and we love thermal. It’s very important. So let’s talk about it. Let’s focus on the right side of the chart. We have the entire range of thermal chain technologies, from outside the data center building to inside the rack, everything from a chiller to a new rack CDU or a manifold. Liquid and air cooling coexist for heat collection in the data center of the future. In all cases, liquid and air cooling require heat rejection or heat reuse solutions, including chillers, direct expansion units, and condensers. So it’s not air or liquid; it’s both. We believe from a market value standpoint that air and heat rejection combined will account for 70% of the market, with liquid cooling capturing 30% over the next few years. Air and heat rejection will grow at a 10% CAGR, while liquid cooling will grow at a 30% CAGR, both doing very well. We have serious intentions to be the market leader in liquid cooling. Vertiv's growth in liquid cooling exceeds market growth, and we believe we are rapidly gaining market share. We see that in our orders, and we see orders converting to revenue convincingly. This quarter is a strong example. Slide 6 describes what Vertiv leadership in liquid cooling means. Please focus on the left side of the slide. First and foremost, Vertiv has a complete range of liquid and high-density solutions, particularly in-rack CDUs, 1-phase row CDUs, 2-phase row CDUs, manifolds, and rear-door heat exchangers. We are cold-plate agnostic, and we like that approach as it enables our CDUs to be validated across multiple cold-plate technologies and server brands. We are proud of our portfolio, but there is more to our liquid cooling trend than the strength of our portfolio. It is about future readiness. We are working today on the products that enable the technology roadmaps of the most influential silicon providers. Our products must precede theirs in the field. We are significantly increasing our investment in high-density cooling engineering to continue to lead in the future. The data center of the future will have both air and liquid in varying mixes based on load dynamics and IT refresh cycles. Thus, having the ability to master all cooling technology is essential. Our ability to customize at scale is indeed global. We are on track to scale our liquid cooling technology 45 times by the end of this year. We are not stopping there. The data center expertise and service footprint borrowed from decades of service experience differ vastly among players and for Vertiv. We have about 4,000 service engineers deployed globally, and that number is growing. They need a partner that has the expertise to understand the significant changes ahead and can deliver clear total cost of ownership advantages. Vertiv has a reputation, earned over several decades, for keeping data centers operational. This is what liquid cooling market leadership looks like, and I'm proud of our position. We are seeing this translate into strong orders and now sales. Let's go to Slide 7 and zoom out a bit to our partnership with NVIDIA. You may have seen the recent announcements of our co-development of complete power and cooling reference designs for NVIDIA's GB200 NVL72 platform. We are helping data center operators stay ahead of the challenges while enabling the vision of AI factories. Vertiv's advantages from the previous slide explain why we are uniquely suited to play this important role for the industry and why there is a very organic relationship between NVIDIA and Vertiv. We ensure our technology enables NVIDIA's roadmaps today and in the future. A great example of enabling the industry to be future-ready is our truly unique Vertiv CoolPhase CDU, which facilitates the deployment of high-density liquid cooling where needed without needing to re-engineer the whole data center environment, even in the absence of a chilled water loop. Vertiv can seamlessly integrate the ability to navigate the transition between liquid and air-cooled service. We can develop these unique solutions due to our decade-long expertise around these technologies. So with that, I'll turn it over to David.

David Fallon, CFO

Perfect. Thanks, Gio. Turning to Page 8. This slide summarizes our third-quarter financial results. Organic net sales were up 19%, $114 million above the midpoint of guidance, with the upside driven by favorable timing of shipments in both the Americas and EMEA. Our backlog is strong, and with available production capacity, we were able to realize these additional sales previously projected for the fourth quarter. Double-digit organic growth was seen across all three regions, with EMEA leading the way at 25%, demonstrating that strength in data center demand is not only an American story but indeed global. Adjusted operating profit of $417 million was $121 million higher than last year, primarily driven by higher volume and commercial execution. Adjusted operating margin of 20.1% represents a significant milestone, surpassing 20% for the first time. We shared last year in our investor event a long-term ambition of 20% plus. It is safe to assume that the 0.1% above the 20% in the third quarter does not define the upper limit of that plus. We believe there is plenty of upside opportunity with margins, and we plan to share our revised long-term ambition in this year's November 18th Investor event. Now back to third-quarter margins. We did incur launch costs for our new infrastructure solutions facility in Pelzer in the third quarter, as well as at several existing facilities where we are expanding internal capacity, and these launch costs and some project mix negatively impacted third-quarter growth margins compared with the second quarter. Some of these launch costs were one-time in nature, but others are permanent, and we expect those to be more fully absorbed in gross margins with higher volume going forward. Finally, on this page, our adjusted free cash flow was $336 million, $115 million better than last year, driven by higher profitability and improved trade working capital, which declined to 16% of annualized third-quarter sales. This figure had been consistently above 20% in recent prior years, indicating good progress, but once again, similar to margins, there's still a ton of opportunity. Our adjusted free cash flow conversion was 116% in the third quarter, the second consecutive quarter over 100%. Now turning to Slide 9, this slide summarizes our third-quarter segment results. As mentioned, we saw double-digit sales growth across all three regions. The Americas had another strong quarter, with organic sales up 21%, driven by broad strength across multiple market verticals and product lines, including a material contribution from liquid cooling in the third quarter. Adjusted operating margin expanded 470 basis points, largely driven by operational leverage and strong commercial execution. APAC sales increased 10% organically, with China growing double digits. Although we are pleased with this growth in China, which represents about 10% of our overall business, we are not projecting that same double-digit growth in the fourth quarter, possibly out of prudence or conservatism, as China still operates in a challenging macro environment. APAC adjusted operating margin declined 260 basis points from the third quarter of 2023, primarily due to unfavorable mix and a favorable discrete item in last year's third quarter. However, APAC operating margins did improve sequentially from the second quarter as expected, and we anticipate further sequential margin improvement in the fourth quarter. EMEA organic sales increased 25%, driven by continued strong demand from colocation and hyperscale customers, and very encouragingly, growth was broad across our product and service portfolios. Looking forward, as Gio mentioned, visibility into a strong pipeline of AI-related demand in EMEA is becoming clear. Adjusted operating margin expanded by 400 basis points to 25.9%, leading the competition with the Americas for the second consecutive quarter. However, we anticipate another close race between those two regions as we close out the year. Moving to Slide 10, this slide summarizes our fourth-quarter guidance. We expect a strong close to the year, with fourth-quarter sales expected to increase by 13% organically, with regional profiles reflecting Americas up high-teens and APAC and EMEA up mid to high-single digits compared to last year’s fourth quarter. We expect fourth-quarter adjusted operating profit of $437 million at the midpoint, with adjusted operating margin of 20.4%, continuing the expansion from the third quarter margin driven by operational leverage, commercial execution, and productivity gains. We anticipate year-over-year incremental margins of 39% in the fourth quarter, which translates into a projected 46% incremental margin for the full year. Next, turning to Slide 11, our full-year guidance. We are increasing guidance for sales by $140 million, a combination of volume and foreign exchange. Full-year expected organic growth is now 14%, with this increase primarily driven by the Americas and EMEA, both expected to post mid-teens growth from 2023. We are increasing our full-year adjusted operating profit guidance by $50 million to $1.485 billion with $32 million from the third-quarter beat and $18 million from the fourth-quarter raise. Full-year adjusted operating margin is expected to be 19% at the midpoint, 30 basis points higher than our previous full-year guidance and a 370 basis point improvement from 2023. We are certainly pleased but not satisfied with our margin performance in 2024. In November of last year, we initially guided to 16.7% versus the 19% we are currently guiding. The consistent quarterly beats and raises this metric demonstrate our continued progress with operational leverage, commercial execution, and productivity business-wide, driven by the Vertiv operating system, and as mentioned, more to come. Our projected 2024 adjusted diluted EPS of $2.68 is more than 50% higher than 2023, resulting in a very healthy PEG ratio. The higher earnings per share is primarily driven by higher adjusted operating profit. We continue to provide additional information on income taxes and share count in the appendix of this presentation, and we will discuss any details on either of these topics after the call. Our raised full-year adjusted free cash flow guidance is now $1 billion, an increase of $125 million from prior guidance. This implies fourth-quarter adjusted free cash flow of approximately $230 million and a projected net leverage at year-end of approximately 1.2 times, providing the needed flexibility to exercise our capital deployment strategy going forward. In conclusion, we believe that a strong fourth quarter exit in 2024 indeed positions us very well for a strong 2025. So with that said, I turn it back over to Gio.

Giordano Albertazzi, CEO

Well, thank you. Thank you, David. As we think about 2025, let’s go to Slide 12. In a nutshell, we are excited about the year ahead. The market is strong, and we're certainly feeling the AI tailwinds that should continue to strengthen next year. We have good visibility, a sharp executional focus, and expect price cost to be positive. This results in our expectation for growth in 2025 to be higher than our growth in 2024, with expected expansion of adjusted operating margins and strong free cash flow generation. Let’s go to Slide 13. This is a quick reminder: we have an upcoming investor event in Atlanta, Georgia on Monday, November 18. It is also an opportunity to tour our booth at SC24 the following morning. We hope to see you there. To summarize, let’s go to Slide 14. The data center market is strong, and it is coming towards Vertiv. We are ready for this. Not only are we delivering strong growth, but we are also demonstrating our ability to deliver on profit and cash convincingly. We have raised our full year guidance again, and we continue the relentless pursuit for better results. There is always room for improvement, and that is the mindset we adopt every day. We stay humble and focused with an intensity to step up. This is the right time to go faster, drive differentiation, and deliver premium results. I hold the Vertiv team and myself directly accountable to do just that. So with that, I’ll turn it over to the operator, Nadia, for Q&A.

Operator, Operator

Thank you. We will now begin the question-and-answer session. The first question goes to Andrew Obin of Bank of America. Andrew, please go ahead.

David Ridley Lane, Analyst

Hi, this is David Ridley Lane on for Andrew. As hyperscalers are starting to build out multilocation campuses, how does the order timing for you work out? Do you receive an order for all the buildings at the campus at a single point in time? Do those get phased in over time, and how is that part of the market developing for you?

Giordano Albertazzi, CEO

First of all, we definitely see these large campuses and large data center deployments happening at really large scale, and not just in scale with the buildings but also in the market. In general, we get good visibility on the entire program, but the exact way in which purchase orders (POs) are placed really depends on the individual hyperscaler or even speaking about very large deployment colocation, as some colos have very large deployments themselves. But again, the prevalent model is they place POs for the buildings that are currently deployed. As we mentioned in a previous call, we have longer visibility in terms of POs that we receive from this part of the market, which is a good thing.

David Ridley Lane, Analyst

Thank you very much.

Steve Tusa, Analyst

Hey guys, good morning.

Giordano Albertazzi, CEO

Good morning, Steve.

David Fallon, CFO

Hi, Steve.

Steve Tusa, Analyst

Just a backward-looking question on Q3 in the orders. Obviously, in the second quarter, you beat your guidance by several hundred million dollars. You talked about a couple of things moving in, or at least hitting in that quarter, that maybe you had less visibility on at the beginning. When you look at the outperformance this quarter, which was fine but more modest, was there anything that pushed out on you in the quarter? Did you hit most of what you expected to hit from an orders perspective around timing? My follow-up would be, there are a lot of questions around the ODMs who are talking about their market share in liquid cooling. Can you clarify how you guys fit into that, how much you supply them, and how you're competing with them as well? Just to clarify the relationship between you guys and the ODMs on liquid cooling. Thank you.

Giordano Albertazzi, CEO

Sure, Steve. To the first question, we were talking about projects and order lumpiness. The market has not changed in that respect. We have in Q3 exceeded our guidance and orders, and our expectations have materialized nicely. However, it is particularly important for us to maintain a strong trailing 12 months. We will not specifically comment on whether any specific job moved in or out. We're pleased with how the pipeline is unfolding into orders, and we have strong pipelines going forward, experiencing quarter-on-quarter growth over several quarters. With respect to your second question around ODMs, they play an important role in the go-to-market for us. ODMs often integrate liquid cooling technology in what they do, sometimes with private labeled products or with products that are the original vendor labeled. We do not consider that part of the market as competition but rather as an opportunity to synergize with them.

Steve Tusa, Analyst

Great. Thank you.

Amit Daryanani, Analyst

Yes. Good morning. Thanks for taking my question. Gio, I have a clarification: I understand your decision to not provide order guidance going forward. Is it fair to think that you folks will keep disclosing order numbers on a trailing 12-month basis going forward? If you just clarify that, that would be really helpful. My question is really about the 2025 revenue acceleration that you’re talking about. Could you talk about how you expect backlog to trend in that framework? Is acceleration only coming from backlog normalizing, or do you think there’s enough demand that the backlog can grow and revenues can accelerate in 2025? Thank you.

Giordano Albertazzi, CEO

Yes, to your point: as indicated in the last call, we are moving to a trailing 12-month figure, which is indeed the best metric considering the order lumpiness. The lumpiness of orders is meaningful, combined with the individual order sizes that can become very significant. Thus, using the trailing 12-month figures is the way forward. Regarding revenue acceleration in 2025, it may be premature to elaborate, but suffice it to say that we are operating in a favorable market. We are winning, experiencing strong pipelines, and seeing accelerated growth globally. We are optimistic overall.

Amit Daryanani, Analyst

Great. Thank you.

Andy Kaplowitz, Analyst

Good morning, everyone.

Giordano Albertazzi, CEO

Good morning.

Andy Kaplowitz, Analyst

Gio, maybe just to clarify the competition question a little more: Are you still achieving the same win rate or even a higher win rate as the market moves further into liquid cooling, and as Blackwell-powered data centers begin to ramp up? Are you getting that $3 million to $3.5 million per megawatt content that you told us about at your last Investor Day on the high-density compute-focused projects that are out there at this point?

Giordano Albertazzi, CEO

We will not specifically discuss win rates and how they evolve, as it may be too detailed. We have different expectations for different product lines. We are satisfied with our win rates, and they align with our market share ambitions. This is also true for liquid cooling. Concerning the TAM per megawatts, we are still in transition but the signals indicate an additional $0.5 million TAM per megawatt that we indicated in November last year.

Andy Kaplowitz, Analyst

Thank you.

Jeff Sprague, Analyst

Hey, thank you. Good morning, everyone. Coming back to Slide 5, could you speak to the extent to which customers historically bought across the thermal solution spectrum? I would imagine it was minimal historically, but is that changing with AI and project complexity? Can you demonstrate to customers that Vertiv, integrating all three, can deliver better efficiency and energy savings compared to using best-of-breed components?

Giordano Albertazzi, CEO

The sales mix has historically been a combination of both individual products and full portfolios. We frequently discuss the entire portfolio with customers, which increasingly includes thermal solutions. This is especially true as technology dramatically evolves. Having the entire portfolio is an advantage for us because larger customers value an integrated solution. They appreciate being able to discuss the problem and the entire solution rather than just individual components. Regarding total cost of ownership, yes, we can demonstrate that our integrated solutions offer superior efficiency and energy savings due to their combined advantages.

Brett Linzey, Analyst

Hello, thanks for the question. Just wanted to come back to thermal management. You have a long-term forecast, and you guys are very active on new investments. Should we expect thermal application growth to start outpacing the power side going forward? Is there any major divergence we should consider?

Giordano Albertazzi, CEO

In the very large thermal portfolio, liquid cooling will indeed characterize high growth rates due to market dynamics and our increasing market share. However, there is balance across our various product lines. The AI-driven high-density compute will have a positive impact on our entire portfolio. Furthermore, power management is also expected to grow, driven by ongoing demands as densification continues. Thank you.

Operator, Operator

Thank you. This concludes our question-and-answer session. I would like to turn the conference call back over to Gio Albertazzi for any closing comments.

Giordano Albertazzi, CEO

Thank you very much for joining us today. I want to extend a big thank you to the Vertiv team for another strong quarter of execution. We appreciate your support and questions, and we look forward to seeing you in Atlanta.

Operator, Operator

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.